Educational Articles

Utilities as a Safe Haven

Paul E. Debbas, CFA
| November 08, 2011

Historically, utility stocks have been known for their defensive characteristics. That is, when the stock market is weak, they usually outperform the broader market averages. Conversely, they are laggards in bull markets. In view of the stock market’s pronounced volatility since early August, it is worthwhile to look at this issue.

The biggest reason for the greater stability of utility equities is their generous dividend payments. In early November of 2011, the average electric utility issue yielded 4.3%, and the average gas utility equity yielded 3.7%. A high dividend yield often lessens a stock’s downside risk. In addition, utilities have less exposure to economic cycles than most other industries. Residential electric usage fluctuates largely due to weather patterns. Gas and water utilities have less sensitivity to the economy than electric companies.

So far in 2011, utility stocks, as a group, have demonstrated the relative stability that investors expect from them. As of early November, the Value Line (Geometric) Average was down 12%, while the Value Line Utility Average was up 1%. And when dividends are factored in, the relative outperformance of the utility sector is even greater.

Stock market volatility has been more prevalent since early August. Since August 3, 2011 (the day before the Dow Jones Industrial Average declined more than 500 points), the Value Line Geometric Average has fallen 8%, while the Value Line Utility Average has dropped 2%. This was another outperformance by the utility sector.

Further evidence of stability is shown in the Price Stability Index that The Value Line Investment Survey calculates for each stock it covers. Of the 53 equities in the Electric Utility Industry, all but five have a Price Stability Index of 90 or better. (The numbers represent percentiles.) All 12 gas utility stocks are rated 95 or better for Price Stability, and four of the six water utility issues are rated 90 or better.

The fact that utilities, as a whole, are more stable than the broader market does not mean that this is true for each stock. One of the aforementioned five electric utilities is Constellation Energy (CEG). In 2008, well over half of the company’s business was in nonregulated operations. Its stock price was more than $60 a share in the first week of September. Then, after the credit crisis erupted in the middle of the month, the quotation fell to as low as $13 a share before settling in the mid-$20s by the end of the month. That same year, PNM Resources (PNM), another one of the five laggards, cut its dividend due to weak earnings.

When utility stocks are referred to as a “safe haven,” this means that (in general) they are safer than nonutility equities. However, even if they perform well on a relative basis, this does not mean that they cannot perform poorly on an absolute basis. This was illustrated in 2008, when the Value Line (Geometric) Average plummeted some 40%. The Value Line Utility Average fared far better, but still dropped about 20%. At the end of the day, as long as investors are cognizant of what can occur in an exceptionally bad year for stocks, it is reasonable for conservative accounts to regard utility issues as a safe haven in a volatile market.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.